Home Equity in Retirement

Transcription

1 Tapping STUDY Home Equity in Retirement The MetLife Study on the Changing Role of Home Equity and Reverse Mortgages JUNE 2009

2 The MetLife Mature Market Institute Established in 1997, the Mature Market Institute (MMI) is MetLife s research organization and a recognized thought leader on the multi-dimensional and multi-generational issues of aging and longevity. MMI s groundbreaking research, gerontology expertise, national partnerships, and educational materials work to expand the knowledge and choices for those in, approaching, or caring for those in the mature market. MMI supports MetLife s long-standing commitment to identifying emerging issues and innovative solutions for the challenges of life. MetLife, a subsidiary of MetLife, Inc. (NYSE: MET), is a leading provider of insurance and financial services to individual and institutional customers. MetLife Bank is a provider of forward and reverse mortgages. For more information about the MetLife Mature Market Institute, please visit: Contact: MetLife Mature Market Institute 57 Greens Farms Road Westport, CT (203) Fax (203) MatureMarketInstitute@MetLife.com National Council on Aging The National Council on Aging (NCOA) is a nonprofit service and advocacy organization headquartered in Washington, DC. NCOA is a national voice for older Americans especially those who are vulnerable and disadvantaged and the community organizations that serve them. It brings together nonprofit organizations, businesses, and government to develop creative solutions that improve the lives of all older adults. NCOA works with thousands of organizations across the country to help older adults find jobs and benefits, improve their health, live independently, and remain active in their communities. Contact: National Council on Aging 1901 L Street, SW, Fourth Floor Washington, DC (202) Research for this study was conducted by Barbara R. Stucki, Ph.D., Director of the Reverse Mortgage Initiative for NCOA MetLife

3 Table of Contents Executive Summary...4 Introduction...6 Home Equity as a Resource...8 How Much Equity Is Left?...8 Diverse Needs...9 Issues and Challenges Strategy #1 Increase Income Security Sustain Cash Flow Increase Annuitized Income Issues and Challenges Strategy #2 Enhance Financial Resilience Self-Insurance Financial Buffer Issues and Challenges Strategy #3 Improve Debt Management Transfer Debt Defer Mortgage Payments Issues and Challenges Implications Need for Financial Flexibility Guiding Principles Partnering to Promote Innovation Endnotes TAPPING HOME EQUITY IN RETIREMENT 3

4 Executive Summary Maintaining financial security as an older adult in America has always been difficult and a challenge. Today s issues of living longer, rising costs, fewer defined benefit pension programs, and diminished investment values have put extraordinary pressure on finding new sources of income and creative ways to stretch out accumulated savings. To supplement their budgets, older homeowners are starting to tap their housing wealth by taking out homeequity loans or reverse mortgages. But with little guidance, they are often unsure about how to use this asset as an integral part of their financial strategy, rather than as a last-resort financial resource. Older adults with lower to moderate incomes face the biggest challenges, since the bulk of their non-pension wealth is usually tied up in their homes. The purpose of this study is to examine different options for using home equity to respond to these new retirement realities. The study approaches the issue from a consumer perspective, since older Americans whose incomes are under duress are on the front line of change. The analysis reviews national demographic data to provide a snapshot of how households age 62 and older use this asset to cope with financial shortfalls. It examines recent surveys of the changing attitudes of older adults and Baby Boomers to provide a glimpse into the problems which may lie ahead and the need for new solutions. The study also includes existing economic and housing research that evaluates the capacity of housing wealth to sustain consumption in retirement. The aim of this effort is to encourage the development of a more robust and holistic approach to managing financial risk in retirement through the use of home equity. It reflects a growing awareness that narrow visions and simple strategies will not be enough to allow Americans to grow old with dignity and security. The diverse data presented here also offers a foundation to begin discussion about new ways to view reverse mortgages as part of a financial strategy to increase income security, enhance financial resilience, and improve debt management. The research indicates that a small but growing number of older people use housing wealth earlier in retirement to maintain financial independence, rather than saving this asset as a last resort. Some are beginning to tap this asset to ensure that they will have enough income to meet basic expenses. With limited savings, other older homeowners are using a portion of their home equity as a financial buffer to cope with unexpected health and household expenses. For many older adults, these decisions are driven by growing consumer debt. 4

5 The findings of this study suggest that home equity will not offer a simple solution to the growing financial problems of aging Americans. The choices that these older homeowners make, and the problems they face, also highlight the difficulty of shifting from a financial planning strategy that aims to preserve housing wealth to one that uses this asset as a retirement resource. As millions of Baby Boomers begin to enter retirement, it appears that many indicate interest in using this asset to maintain their lifestyle throughout retirement, if necessary. The findings suggest that the financial services industry, policymakers, and advocates for older adults cannot ignore home equity in their efforts to promote retirement security. The diverse needs and expectations of older homeowners indicate that it will be important to strengthen retirement planning strategies beyond simple models of asset accumulation and decumulation. The study identifies four key principles that should guide the development of a more comprehensive approach to ensuring financial security in later life: Use a holistic, person-centered framework Strategies need to shift from product-focused solutions to comprehensive financial plans that include home equity as an integral part of retirement security. Promote flexibility Older homeowners need multiple, affordable products that can meet both their long- and short-term financial goals in retirement. Address changes over the life course Financial, health, family needs, and risks change as people grow older and need to be considered when home equity is included in financial planning. Offer solutions that strengthen financial security A house is more than a financial asset; it is also a home. Older homeowners across the economic spectrum are looking for cost-effective options that give them peace of mind through additional sources of retirement income. These guiding principles provide a foundation upon which to develop home-equity products and public policy that can better serve aging homeowners. They also highlight the importance of greater mutual understanding and cooperation to accelerate learning and spur the development of affordable solutions and effective public policy to better serve older homeowners. Financial professionals can work with consumer advocates to strengthen financial literacy programs for homeowners of all ages. Organizations that offer reverse mortgage counseling, debt management, and benefits counseling need to work together to make sure that older Americans use home equity wisely. By working together, the financial services industry, U.S. Department of Housing and Urban Development (HUD), and aging organizations may be able to speed up the development and testing of lower-fee reverse mortgages and other financial products that can meet the needs of homeowners with modest housing wealth. Recent trends show a small but increasing use of home equity among older homeowners when considering the size of the eligible population. However, they serve to remind us that people are not complacent about their growing retirement risks. Americans are proud of their resourcefulness. Growing numbers of older homeowners will benefit from additional support and guidance, since the decisions that homeowners make about this valuable asset will have long-term ramifications for the well-being of older Americans and for our nation. TAPPING HOME EQUITY IN RETIREMENT 5

6 Introduction This study examines different options for using home equity to cope with financial shortfalls in later life. The study incorporates a wide array of consumer data to highlight the decisions that today s older adults make about this asset, and the need for new solutions as the oldest Baby Boomers begin to enter retirement. The 2007 American Housing Survey and the 2007 Survey of Consumer Finances provide a snapshot of the prevalence of home loans among older homeowners. Other consumer surveys cited highlight the changing attitudes of older adults and Baby Boomers toward the house as a source of cash. This data provides a glimpse into the opportunities and issues which may lie ahead and the potential for new solutions to an evolving challenge. The concerns of homeowners in or nearing retirement put a human face on a complex economic issue. The choices that they make, and the problems they face, also highlight the difficulty of shifting from a financial planning strategy that aims to preserve housing wealth to one that uses this asset as a retirement resource. Most older adults have limited amounts of home equity, and face difficult decisions and trade-offs: Should they tap housing wealth early in retirement to sustain income security? Should they wait and use this asset as a financial buffer to cope with an increasingly uncertain future? How will the need to manage growing amounts of consumer debt influence these decisions? It is not just older Americans who worry about using home equity wisely. Policymakers are concerned that older adults who tap this asset to pay for everyday expenses will have fewer resources to deal with declining health in later life. Many states already struggle to pay for public programs, such as Medicaid, that assist older adults with low incomes and those who are impoverished by health expenses. Financial shortfalls among middle income older adults that accelerate the need for public assistance could make these fiscal pressures even greater. Some financial professionals are also questioning the value of retirement planning models based on steady asset accumulation and decumulation in our uncertain economic climate. 1 It is unclear whether such traditional financial advice will help older homeowners use 6

7 home equity effectively to manage retirement risks. To provide a more comprehensive perspective, the study includes existing economic and housing research that evaluates the capacity of housing wealth to sustain consumption in retirement. The aim of this study is to encourage the development of a more robust and holistic approach to managing financial risk in retirement through the use of home equity. This effort reflects a growing awareness that narrow visions and simplistic strategies will not be enough to allow Americans to grow old with dignity and security. An important objective of this study is to use the experiences of older homeowners, along with existing research, to outline specific principles that can guide the design of new solutions. The diverse data presented here also offers a foundation to promote discussion among the financial services industry, government policymakers, and aging organizations. Greater mutual understanding and cooperation can accelerate learning and spur the development of affordable solutions and effective public policy to better serve older Americans. TAPPING HOME EQUITY IN RETIREMENT 7

8 Home Equity as a Resource As a starting point for examining home equity as a retirement resource, it is important to consider two questions. After the collapse of the real estate market, how much money is left in the house to pay for retirement expenses? Second, how willing are older homeowners to use this asset as more than a last resort to maintain their well-being? The need to use the house as a source of cash is influenced by the availability of other financial resources. Some homeowners with lower to middle incomes also find that the choices available to tap this asset are limited because they do not qualify financially for certain home loans. Many wonder whether the equity they have left in their homes can offer any solutions to enhance retirement security. How Much Equity Is Left? Economists estimate that homeowners in the United States lost a total of $3.3 trillion in property value in The magnitude of these price declines varies across housing markets in different parts of the country. In communities where houses appreciated dramatically, such as Los Angeles, single-family home values dropped on average by over 31%, from $594,000 to $402,000 between 2007 and Price declines were smaller in the South (7.5%) and Midwest (10.6%), where home values have remained at more modest levels. These figures may underestimate true home values, since many properties that are sold today are foreclosures offered at deeply discounted prices. Real estate declines reduce the overall wealth of all homeowners, especially older ones. The declines are especially problematic for people who have to sell their homes in a declining market. However, homeowners who can weather the storm may see home values rise again in the future. This is an option for many older Americans, who prefer to stay in their homes for as long as possible, and have realized relative gains from their original home purchase price. In 2007, almost 80% of older households owned a home, including almost 78% of those age 75 and older. 4 Figure 1: Mortgage Status Among Homeowner Households Age 62 and Older Regular Mortgage Only 21.5% No Home Loan 64.5% Regular Mortgage + Home-Equity Loan 4.8% Source: American Housing Survey, Home-Equity Loan Only 8.5% Reverse Mortgage 0.7% 8

9 Among today s older adults, the decision to liquidate home equity is often influenced by deeply held values. As a consequence, some economists and policymakers have questioned whether home equity should be viewed as a retirement asset. Older homeowners tend to see the house as a place to live rather than a source of cash. Many are oriented to leaving the family home as a bequest to their children. In 2007, almost 65% of the 21.7 million homeowner households headed by someone age 62 and older owned their homes free and clear of any mortgage (see Figure 1). Although older adults want to preserve home equity, many are finding it harder to achieve this goal in the face of rising economic challenges. The proportion of households age 65 and older that have a home loan has grown significantly in recent years, from 24% in 1999 to 32% in There are two explanations for this trend. One reason is that more homeowners are entering retirement without having paid off their regular mortgage. In 2007, about one in five homeowner households age 62 and older still had a regular mortgage (see Figure 1). Due to historically low interest rates at the early part of this decade, many (some older workers and retirees) may have been able to refinance their mortgage and reduce their monthly payments to levels they feel they can handle in retirement. Some older homeowners are also cashing-out a portion of their housing wealth. Over 13% of homeowner households had a home equity lump sum payment or line of credit in A significant proportion of these borrowers are making monthly payments on both an existing mortgage as well as a home-equity loan. In addition, about 1% of older households have taken out a reverse mortgage. Although the number of these borrowers is small, the rapidly growing interest in and knowledge of reverse mortgages is often seen as a signal that older homeowners are becoming more willing to use home equity as a retirement resource. The popularity of these loans may also reflect the fact that, unlike conventional loans, lenders do not consider a borrower s income or credit history to determine eligibility for a reverse mortgage. However, the maximum amount that can be borrowed is limited by the value of the home, the homeowner s age, and an overall limit set by the Federal Housing Administration (FHA). Diverse Needs The resources that people can accumulate during their working years have a major impact on their financial well-being as they grow older. Periods of economic boom and recession also affect how people born at different times experience retirement, and the challenges they face. To gain insights into these diverse experiences, and the need to tap home equity, homeowners households were divided into four groups. These groups reflect differences in annual income and home values, and include: House-poor and cash-poor Low incomes (under $20,000) and home equity under $125, House-rich and cash-poor Low incomes and homes worth at least $250, Moderate wealth This group included two types of households: a) those with low incomes and homes worth $125,000 to under $250,000, and b) those with moderate incomes between $20,000 and $40,000 and homes worth less than $250,000. House-rich or cash-rich This group included two types of households: a) the cash-rich those with incomes above TAPPING HOME EQUITY IN RETIREMENT 9

10 Home Equity as a Resource $40,000 and homes worth less than $250,000, and b) the house-rich those with moderate incomes between $20,000 and $40,000 and homes worth at least $250,000. House-rich and cash-rich Households with incomes of at least $40,000 and homes worth at least $250,000. One in five older households is cash-poor (see Table 1). They are typically among the oldest homeowners, with a median age of 76. For these older adults, whose lives were likely touched by the Great Depression, the current economic slump is nothing new. Many have learned over many years how to cope with financial shortfalls. Their life experiences may also have limited their ability to get a good start in life, which may account for their lower education levels. With very modest incomes, and an aversion to debt, most of these older adults do not have a mortgage. Encouraging them to take out a home loan could be risky, since their limited financial literacy often makes them targets for financial fraud and abuse. The HUD HECM (Home Equity Conversion Mortgage) reverse mortgage program was originally designed to help house-rich and cash-poor older adults use their substantial housing wealth to improve their financial well-being. About 30% of older homeowner households fall into the moderate wealth group. While these older adults are not poor, they may still fall short of economic security due to their modest incomes and housing wealth. As a result, they may be interested in using home equity as a buffer against unexpected health expenses or home repairs. At the higher end of the middleincome group, house-rich or cash-rich older homeowners have a more substantial financial cushion to sustain them in retirement. Most Table 1: Attributes of Homeowner Households Age 62 and Older, by Wealth Status Median Household Values Age of householder Home value $409,000 $175,000 $125,000 $350,000 $65,000 Household income $81,900 $49,800 $25,324 $12,468 $12,000 Other Household Demographics Married 75.9% 64.9% 48.0% 27.3% 22.7% Has a college education 55.2% 34.1% 15.6% 20.7% 8.3% Householder worked last week 32.6% 24.8% 12.5% 5.7% 5.5% No mortgage 48.1% 59.7% 71.6% 70.8% 79.3% Total AFFLUENT House-rich and cashrich House-rich or cash-rich MIDDLE INCOME Moderate wealth Homeowner households age 62+ 4,353,625 6,449,825 6,562,602 1,037,121 3,348,454 % of total households (21.75 million) 20.0% 29.7% 30.2% 4.8% 15.4% Source: National Council on Aging (NCOA) calculations based on data from the American Housing Survey, House-rich and cashpoor POOR House-poor and cashpoor 10

11 homeowner households in this group are married (64.9%) and one-quarter (24.8%) are still working. However, fewer have paid off their mortgage (59.7%), which can be an additional stress on the monthly budget. Affluent older homeowners are relatively young (median age 69) and are predominantly married couples. These households have sizable financial resources, which may reflect the fact that one-third (32.6%) are still in the labor force. Over half (51.9%) are also still making monthly mortgage payments. A challenge for many of these homeowners will be whether they can afford to retire. They may be interested in exploring new options to incorporate housing wealth in their asset allocation strategies. Issues and Challenges Despite their limited retirement resources, only 14% of homeowners age 62 and older have decided to use a home-equity loan or reverse mortgage to get cash from their houses. Traditional attitudes toward the house may explain why some older Americans are reluctant to tap home equity. The fact that older adults still overwhelmingly select home loans that require monthly payments may also be a factor in this decision. Borrowers are vulnerable to financial stress or foreclosure when faced with rising expenses or declining income (i.e., reduction in Social Security benefits or loss of spouse s pension). Reverse mortgages generally do not affect Social Security and Medicare benefits. However, needs-based benefits, such as Medicaid and Supplemental Security Income (SSI), may be impacted. Most reverse mortgages, in addition to interest charges, have an origination fee, closing costs, a mortgage insurance premium, and a monthly service fee. These amounts can be paid by the reverse mortgage itself, so there is no immediate burden to the borrower. The costs are added to the principal and paid with interest when the loan becomes due. Unlike a home-equity loan or traditional mortgage, with a reverse mortgage there are no monthly payments. The loan becomes due when the borrower sells the home, permanently moves out, vacates for a period of 12 months, or when all the homeowners are deceased. At that time, the loan principal, interest charges, and any fees must be paid in full. The need to tap home equity depends on the availability of both financial and social resources. These factors vary significantly among the four different housing groups. As a result, older homeowners may decide to tap home equity for many different reasons, such as a source of additional monthly income or to manage debt. Older adults financial situations also affect the loan options that they can use to liquidate a portion of their housing wealth. Affluent older adults can select from a wide range of conventional loans. Older homeowners who do not qualify financially for a regular mortgage may end up with a subprime loan which carries a higher interest rate and the risk of financial exploitation. These findings suggest that one-size-fits-all solutions will not be adequate to ensure retirement security for homeowners across the economic spectrum. Although the numbers are small, it appears that older Americans increasingly see their homes not just as secure places to live, but also as collateral for a loan. It will be important to monitor this evolving trend to understand how homeowners who are in or nearing retirement use this asset to solve financial problems. Researchers should also track changes in mortgage lending to older adults. One challenge is that federal sources of data on lending practices, such as the Home Mortgage Disclosure Act (HMDA) database, do not collect information on the age of borrowers. TAPPING HOME EQUITY IN RETIREMENT 11

12 Strategy #1 Increase Income Security The foundation for retirement security has traditionally likened to a three-legged stool consisting of savings, pensions, and Social Security. Recent financial trends suggest that this conventional approach is becoming less effective. The savings rate among Americans has declined significantly since the 1980s reaching its lowest level in 2004 since the Great Depression although it recently turned upward (see Figure 2). Compounding these cash shortfalls is the decline of defined benefit plans, which leaves many Americans facing a future with less guaranteed retirement income. To maintain their standard of living, some older homeowners are starting to convert home equity to monthly income. This approach is a relatively new concept that has gained momentum with the development of reverse mortgages. Financial professionals are also beginning to explore different options for using home equity to increase annuitized income. Sustain Cash Flow As the cost of living continues to rise, many older Americans find it hard to make ends meet. Researchers estimate that nearly 78% of all older adult households do not have sufficient resources to sustain them through their retirement years. 8 Baby Boomers are also concerned about being able to maintain their standard of living as they grow older. Older workers who expect inadequate retirement income, or a less reliable source of income, such as a defined benefit plan, are more likely to plan to use home equity to pay for retirement expenses. 9 Cash-poor older households often find it difficult to pay the bills each month. High monthly expenses can be especially problematic for households who are house-rich and cashpoor. A high proportion of these homeowners are elderly widows who may have seen their income drop significantly when their husbands Figure 2: Shifts in Family Resources % of disposable income 12% 10% 8% 6% 4% 2% 0% Personal Savings Single-Family Home Price Median sale price, in thousands $260 $240 $220 $200 $180 $160 $140 $120 $ Personal Savings Single-Family Home Price Source: Bureau of Economic Analysis National Economic Accounts; Prices for homes with conventional single-family non-farm loans, Federal Housing Bureau Historical Summary, Table

13 Table 2: Financial Challenges of Homeowner Households Age 62 and Older, by Wealth Status Housing Attributes Year bought the home Home built after % 28.8% 25.3% 25.3% 20.9% Electricity bill more than $100/mo. 59.0% 49.0% 38.0% 36.3% 31.8% Real estate taxes $3,000 or more 48.1% 19.8% 8.5% 29.9% 3.7% Other Household Demographics AFFLUENT House-rich and cashrich House-rich or cash-rich MIDDLE INCOME Moderate wealth House-rich and cashpoor Single women householders 15.4% 24.1% 39.1% 57.6% 60.8% Lives in central city or suburb 63.4% 55.3% 48.1% 70.9% 38.0% Source: NCOA calculations based on data from the American Housing Survey, POOR House-poor and cashpoor died (see Table 2). Almost 71% live in central cities and suburbs where the cost of living and property taxes tend to be high. They also have a substantial amount of housing wealth (median value $350,000; see Table 1). By selecting a tenure payment plan, a 75-year-old reverse mortgage borrower with a home worth $350,000 could receive almost $1,500 each month tax free for as long as they live in their home. This amount would more than double their monthly income. Older homeowners who are house-poor and cash-poor may be less likely to benefit from a reverse mortgage. Most of these older adults live in smaller communities and rural areas where home values are relatively low (median value $65,000; see Table 1). They also tend to live in older homes that may need additional repairs in order to qualify for a reverse mortgage. As a result, most of these homeowners would receive very little additional income each month by annuitizing their housing wealth. Most middle-income older adults also have limited amounts of housing wealth that they could use to supplement their incomes. For example, a 75-year-old borrower with a home worth $125,000 could receive about $500 each month from a reverse mortgage. This amount might not significantly increase their standard of living. These funds could increase retirement security for households with moderate wealth by filling gaps between the cost of living and available income. As they feel the pinch, 70% of Americans age 60 and older are already cutting back on essentials such as transportation or food. 10 Others are economizing by lowering the heat or turning off lights, which can significantly increase the chances of a serious accident or illness. One in three older adults fall each year, most commonly in their homes, resulting in almost 1.7 million injuries annually. 11 TAPPING HOME EQUITY IN RETIREMENT 13

14 Strategy #1 Increase Income Security Increase Annuitized Income While some aging homeowners must deal with immediate cash shortfalls, others look ahead and worry that they may come up short. At age 65, American men can expect to live an additional 17 years, and women 20 years, on average. 12 With increasing longevity, there is some chance that they may outlive their retirement resources. Maintaining financial security over many years will be especially challenging for many Baby Boomers who cannot rely on guaranteed retirement income from an employer-sponsored defined benefit pension plan. One option to increase monthly annuitized retirement income is to defer Social Security payments. Retirees receive a reduced monthly benefit at age 62 and progressively larger benefits for each month they postpone benefits up to age 70. Elderly widows could see the greatest benefit, since deferral would increase the expected value of their monthly survivor benefits. 13 To maximize their monthly payments, as well as that of their spouses and other dependents, people near retirement could continue working. However, this option may be difficult for workers in physically demanding occupations, and those who are limited by health problems. To help workers who anticipate a long life, and who must retire before age 70, some financial professionals are recommending a term home-equity loan or reverse mortgage to help pay for everyday expenses for a few years until they are eligible for maximum Social Security benefits. Figure 3 highlights how this strategy could work for a middle-income woman age 62 with a home worth $150,000 and with an annual salary of $50,000. If she chose to retire at age 62, her monthly Social Security payment would be $1,013. If she waited until age 70, she would receive $1,953 per month. To maximize her benefit: She would need to get an additional $1,013 per month from a reverse mortgage for eight years (total $97,248) if she stopped working at age 62, but deferred her Social Security benefits until age 70. This approach would rapidly deplete home equity. Figure 3: Equity Draw-Down with a Reverse Mortgage to Defer Social Security Remaining Home Equity $150,000 $100,000 $50,000 $ Duration of Loan (years) 4 years, $500/mo 8 years, $500/mo 8 years, $1,013/mo Source: NCOA calculations using the Reverse Mortgage Analyzer HECM monthly CTM 200 loan; appreciation rate 2%, expected interest rate 4.91%. 14

15 If she switched to part-time work at age 62, and drew $500 per month from a reverse mortgage to supplement her income until age 70, she could lock in an additional $940 per month in Social Security benefits starting at age 70, and still retain a significant amount of home equity. If she worked full-time until age 66, then switched to part-time work and drew $500 per month from a reverse mortgage for four years, the potential impact on her home equity might be minimal, at current interest rates and with modest (2%) home appreciation per year. The net benefit of this approach would depend on how long a person (and spouse) lived after age 70, changes in interest rates, and the duration of the loan. Borrowers who moved soon after reaching age 70, and paid off their reverse mortgages, would pay less in total interest on their loans than those who continued to live in the same house for many years. Given the complexity of this financing option, older workers would need to carefully evaluate the potential long-term ramifications of this approach. Financial professionals are also exploring the possibility of using home equity to supplement income when the financial market conditions are depressed. In 2008, workers with 401(k) plans worth over $200,000 saw their account balances decline by over 25%. 14 Tapping home equity would reduce the need for retirees to spend money from a recovering retirement account or to liquidate income-generating assets to support consumption. Another option for older homeowners to ensure retirement income would be to buy a longevity annuity with their savings, and tap small amounts of home equity to fill financial gaps until they start to receive their annuity payments. Longevity annuities require a smaller investment than an immediate annuity because they usually do not begin payouts until after age 80 or 85. This approach could be attractive to older Americans who worry that purchasing an immediate annuity will leave them little cash to pay for unexpected expenses or to leave a bequest. Consumers should carefully examine the fees associated with longevity annuities, since they can be expensive. Issues and Challenges A fundamental component of retirement security is having enough income to meet basic expenses. Conventional wisdom encourages people to save as much as possible during their working years so they can maintain their standard of living in retirement. But with sizable losses to retirement savings plans in recent years, along with the growing cost of basic necessities, it is harder for many people to accumulate enough funds to ensure a comfortable retirement. As Americans enter their retirement years, they may need to reevaluate their financial situation and convert some of their housing wealth to income to supplement the family budget. Researchers generally agree that using a reverse mortgage to supplement income can be an important option for house-rich and cashpoor older homeowners who may otherwise live in poverty. 15 However, as shown in Table 1, low-income older adults with sizable housing wealth are relatively rare, and represent less than 5% of all older households. Without additional support, the majority of poor older homeowners are unlikely to benefit from liquidating housing wealth through a home loan. Combining public benefits with modest amounts of home equity could be another option to enable some older homeowners with modest means to continue to live at home with greater dignity and security. TAPPING HOME EQUITY IN RETIREMENT 15

16 Strategy #1 Increase Income Security There is less consensus about the value of annuitizing home equity to support income security among middle-income households. A recent study estimated that the median increase in income for these older adults may be able to increase their income by less than 28% through a reverse mortgage. 16 Many feel that such modest amounts of extra cash will not guarantee retirement security for many older homeowners. 17 A major barrier to annuitizing housing wealth is consumer receptivity to this approach. Taking out a loan to support everyday consumption, rather than to make home improvements or otherwise increase wealth, goes against conventional wisdom. Many older homeowners feel that this strategy is only appropriate for financially desperate older adults. When asked, 36% of homeowners age 65 and older can think of no benefit for older adults to use home equity to stay at home. 18 Older Americans are usually reluctant to annuitize their retirement wealth. This attitude may reflect the fact that many older adults today already have a sizable portion of their income annuitized through defined benefit pension plans and Social Security. Baby Boomers who tap home equity during their working years will have less housing wealth left in retirement. These homeowners may be interested in targeted, short-term home loans that can help them defer Social Security payments or delay the liquidation of depressed equity. Such strategies highlight the new ways in which financial professionals are beginning to incorporate home equity as a retirement resource. Older homeowners need to scrutinize these financing options carefully, to ensure that short-term solutions do not grow into longterm problems. Younger borrowers should also weigh the benefits of taking out a reverse mortgage early in retirement, since the amount that a borrower can receive from these loans increases substantially with age. Mandatory reverse mortgage counseling by HUD-approved agencies is an important source of independent information about these loans. Consumer advocates and the financial services industry have raised concerns about crossselling annuities and other financial products with reverse mortgages. The Housing and Economic Recovery Act of 2008 strengthens consumer protections by forbidding lenders from requiring borrowers to buy other financial products (such as annuities or insurance) as a condition for taking out a reverse mortgage. Also, the Financial Industry Regulatory Authority (FINRA) has an investor notice strongly cautioning investors against using home equity to purchase investments. FINRA has also put financial service firms on notice that recommending the use of home equity to purchase investments is not a suitable recommendation. Homeowners who are considering these options will need additional financial education to make wise decisions. 16

17 Strategy #2 Enhance Financial Resilience Retirement has always been a time of financial uncertainty. Not knowing how long they will live, or the extent of their health needs, makes it difficult for older people to decide when to spend their financial resources. With increasing economic uncertainty, they face even greater challenges. As an alternative to using home equity for regular consumption, older adults may want to improve their retirement security by preserving this asset as a cushion against unexpected events. Older Americans who own their homes free and clear of any mortgage often value the house as a type of insurance. The challenge for homeowners who opt for this traditional use of home equity is knowing how long to wait, especially if they face increasing financial hardship. They also need to decide how to tap this asset when that rainy day arrives. Those who see home equity as a last resort typically wait to liquidate home equity until they face a major life change, such as widowhood or the nursing home needs of a spouse. 21 At this point in life, homeowners usually decide to sell their homes. A small proportion of older homeowners are beginning to use home-equity loans to pay for health and long-term care needs. A 2007 survey by the Commonwealth Fund found that 8% of older adults with medical bills or medical debt problems took out a mortgage or loan to pay for these costs. 22 About 28% of reverse mortgage Self-Insurance Most Americans want to continue to stay at home for as long as possible. They worry about large and unexpected out-of-pocket costs that can disrupt their ability to sustain themselves financially. One of the biggest uncertainties is out-of-pocket costs due to declining health and ability. Medical and long-term care expenses often lead to considerable wealth depletion among older adults who live in the community. 19 Married couples may also want to keep their assets until late in life, to cover the substantial end-of-life medical and funeral costs that can leave widows impoverished. 20 Consumer surveys find that older homeowners today typically preserve home equity to protect themselves financially against potentially catastrophic expenses. TAPPING HOME EQUITY IN RETIREMENT 17

18 Strategy #2 Enhance Financial Resilience borrowers take out this loan due to concerns about out-of-pocket health and disabilityrelated expenses. 23 Only about 5% of these borrowers use their loan funds for immediate health needs, suggesting that they may be planning ahead for these financial risks. The possibility of receiving help at home, rather than in an institution, may also encourage younger homeowners to tap home equity before they face a health crisis in retirement. A recent survey found that a high proportion of Boomers turning age 62 see long-term care as an important reason to consider a reverse mortgage (see Figure 4). 24 Over 70% of those with very modest retirement assets (household net worth of less than $50,000) may be planning to use home equity to pay these expenses as they grow older. Older Americans often rely on housing wealth because they did not purchase long-term care insurance. Those who wait until their retirement years may also find that they do not qualify for coverage due to an existing health condition or find they can no longer afford it. Policymakers, advocates, and insurance companies have raised serious concerns about using home equity to purchase long-term care insurance. However, home equity may play a different role to support Baby Boomers who buy long-term care insurance. A recent survey found that 84% of Americans who purchased a policy in 2008 were under age To save costs, 76% of these buyers opted for coverage that would pay for a claim lasting five years or less. As they grow older and start to need help, policyholders may want to save their limited insurance coverage to pay for serious disabilities. They could tap home equity to pay for low-cost services that make it easier to stay at home. Small amounts of home equity could also pay for early interventions that can reduce health problems. Figure 4: Reasons Boomers at Age 62 Might Consider a Reverse Mortgage Assets $500K+ $250 $500K $100 $250K $51 $100K <$50K % Immediate Needs Extra Cash LTC Needs Source: MetLife Mature Market Institute, Boomers: Ready to Launch,

19 Figure 5: Rising Home Values, by Age Thousands of 2007 dollars $ Year or older Median value of primary residence. Source: Survey of Consumer Finances Chartbook, Financial Buffer One of the greatest fears of older Americans is ending up in a nursing home. Due to improvements in health and growing options for community living, however, the risk of needing institutional care has declined significantly. As a result, a greater challenge for many retirees will be to maintain financial stability as their needs change over time. Older adults often require assistance with transportation, grocery shopping, or other household chores to cope with declining health. For many people, these added expenses are a real burden. The homes of older adults are also getting older and may erode in value if homeowners do not keep up with repairs and improvements. Researchers have found that appreciation rates for similar homes are considerably smaller when the household head is over 75 years old. 26 This can be a serious financial drain for older adults who already own modest value homes (see Figure 5). With limited amounts of home equity, older homeowners may benefit from using these funds sparingly as a financial buffer to manage the unexpected. The most common approach today is to take out a home equity line of credit (HELOC). Homeowners often use a HELOC to pay for home renovations. Many reverse mortgage borrowers also select a line of credit payment option to address a wide array of basic necessities. This financing strategy can be costeffective, since borrowers only pay interest on the amount that they use from the loan. The popularity of HELOCs, and increasingly reverse mortgages with line of credit payment plans, suggests that an important reason why older Americans already tap home equity is to enhance their financial resilience. In fact, 93% of reverse mortgage borrowers reported that these loans have had a positive effect on their lives. 27 Having a cushion of readily accessible funds can encourage older homeowners to act sooner, to keep small problems from becoming a costly crisis. For example, carbon monoxide fumes from faulty furnaces, gas water heaters, and ranges can have a serious effect on people with heart disease. 28 Replacing a leaky roof or faulty furnace before they cause structural damage or a serious illness reduces the chances that a person will exhaust their retirement savings. TAPPING HOME EQUITY IN RETIREMENT 19

20 Strategy #2 Enhance Financial Resilience Issues and Challenges While many older Americans worry about outliving their savings, an equally important risk may be under-spending that can compromise an older person s health and home environment. The ability to live at home is a dynamic process, where the situation can change rapidly. To make sure that they can stay in control, older adults and family caregivers need to be able to implement effective solutions quickly. A growing challenge will be to help older adults find a balance between using home equity to address immediate needs and preserving this asset to help ensure retirement security. Saving home equity as a last resort may seem to be the safest way to protect this valuable asset, but during periods of economic volatility, such conventional wisdom may no longer serve older adults well. Those who plan to tap this asset only when they have an urgent need may not know how much home equity will be available when they need it, due to fluctuating interest rates and changing home values. It may also be difficult to get a home loan quickly to deal with a crisis situation. The recent crash of the real estate market further highlights the difficulties that older adults can face when they need to sell their home in a hurry. Homeowners who are looking for shorter-term solutions need to be careful about the type of loan they select. Borrowers who opt for a HELOC must have sufficient funds available to pay the loan at the end of the term. They may also want to have an emergency cash fund to ensure that they can continue to make monthly loan payments. As non-recourse loans, reverse mortgages provide important protections against foreclosure. However, using these loans to access small amounts of funds may not be worth the high transaction costs. More research is needed to evaluate the trade offs between the costs versus protections of different home loans. The suitability of using home equity as a financial buffer will also be influenced by the ability of older homeowners to continue to live in their homes. While most older adults want to stay at home for as long as possible, HUD has found that over half of reverse mortgages are terminated within six years after origination. 29 Without additional support for community living, it may be more appropriate for an older homeowner to sell the house rather than incur substantial transaction costs to liquidate home equity through a home loan. 30 These findings also highlight the growing need to strengthen partnerships between aging organizations and the lending community to ensure that older borrowers can meet their life goals. 20

21 Strategy #3 Improve Debt Management A common characteristic of today s older adults, especially those whose lives were touched by the Great Depression, is their aversion to debt. These attitudes may also reflect the fact that there were few opportunities to cash out home equity before the 1980s. Since then, Congress has enacted several laws that have liberalized lending standards and promoted the development of new loan products, including home-equity loans and subprime loans. As retiree incomes are being squeezed, older Americans have been taking advantage of easier access to credit. Several studies show that consumer spending tends to increase as home values rise. 31 Having this extra financial cushion may give homeowners more confidence to spend rather than save for a rainy day. But for some people, their expenditures have been growing faster than their incomes. Younger retirees and Baby Boomers are finding it especially hard to follow the traditional advice of work hard, save money, and stay out of debt. A recent study found that 40% of people age 62 to 75 already have, or expect to have, mortgage debt in retirement. 32 These financial difficulties increase the need for debt management among older homeowners. Transfer Debt It is difficult to maintain financial stability in the face of rising household expenses. For older adults living on a fixed income, the most readily available solution may be their credit cards. The proportion of older families who use this financing option is growing. Since 1998, self-reported credit card use among families headed by someone age 75 and older has almost doubled to 19% (see Figure 6). Among families age 55 to 64, about half carry credit card debt. Even though more older people use credit cards, their balance amounts are not excessive. Families age 65 to 74 typically owed about $3,000 in 2007, while those age 75 and older Figure 6: Families with Credit Card Balances, by Age % Year or older Source: Survey of Consumer Finances Chartbook, TAPPING HOME EQUITY IN RETIREMENT 21

22 Strategy #3 Improve Debt Management had a balance of $800 on average. 33 The challenge for these families is that banks have recently begun increasing interest rates sharply and reducing credit card limits. As a result, many borrowers find they have to make higher credit card payments each month. They often face substantial fees and other penalties when they are late on their payments. Borrowers on fixed incomes may have little left after paying their credit cards to also make monthly mortgage payments. One consequence of ready access to credit has been the growing proportion of people age 55 and older who face bankruptcy. Between 1991 and 2007, the bankruptcy rate among people age 55 to 64 grew from about 6% to over 15%. 34 The proportion of people age 75 and older who face bankruptcy, while small, grew substantially from 0.3% to 2% during this period. The additional pressures that credit card borrowers now face will likely push more older homeowners into bankruptcy or foreclosure. Debt consolidation is a common option to deal with this financial challenge. Under this approach, older adults shift their unsecured consumer and credit card debt to a home loan such as a HELOC or reverse mortgage. When used wisely, this strategy can lower monthly expenses since interest rates for home-secured debt are much lower than those for credit cards today. Older homeowners who use a reverse mortgage for this purpose may increase their available monthly income because they are deferring all payments on their bills until they move out of their homes. Using home equity to avoid bankruptcy can be an important safety net for cash-strapped older adults. However, this approach also presents some challenges. Homeowners need to maintain financial discipline to avoid the risk of going further in debt if they keep using their credit cards. This can be difficult for lowincome families who struggle to meet everyday expenses each month. Defer Mortgage Payments The type of loan that homeowners select to resolve their financial problems can have a big impact on their financial well-being in retirement. One in five older households that are house-poor and cash-poor still has a mortgage (see Table 3). They may face sizable monthly payments, especially if they did not qualify for a regular mortgage, and opted instead for a subprime loan with higher interest rates. Of the 7.7 million older households with housing debt, almost 58% are middle-income families in the moderate wealth or house-rich or cash-rich groups. Although they may not be struggling, additional mortgage payments can increase their financial vulnerability. Based on the Elder Economic Security Standard Index, single homeowners with a mortgage typically need about $19,000 per year in basic income to live in a moderate-cost city such as Minneapolis. 35 They require over $33,000 per year to maintain a basic standard of living in higher cost areas such as Los Angeles. 36 Over half (51.9%) of affluent older homeowner households have some type of home loan (see Table 3). Of households with home loans, they are also most likely to have multiple loans (21.6%). Sizable housing debt can make it hard for affluent homeowners, many of whom still work, to retire and enjoy the balance of their lives. These households are also most likely to be pulling cash out of their houses with homeequity loans. About 45% use this financing option, often in combination with a regular mortgage. Since these borrowers are relatively young (median age 66), they run the risk of spending a large portion of their housing wealth early in retirement. 22